Bruce Company is considering replacing one of its delivery trucks. The truck in question was purchased two years ago at a cost of $41,000. At the time of purchase the truck was expected to have a $5,000 salvage value at the end of its six-year life. Given the use of straight-line depreciation, the truck has a current book value of $29,000. If sold today, the company could get $22,000 for the truck. It costs $20,000 per year to operate the existing truck. The new truck would cost $46,000 and would cost only $14,000 per year to operate. The new truck would be depreciated on a straight-line basis over its four-year useful life to its expected salvage value of $10,000. The company's required rate of return is 14%. Ignore income taxes. (PV of $1 and PVA of $1) (Use appropriate factor(s)
from the tables provided.) Required:1) Identify the cash flows for each alternative by completing the following table: Keep Existing TruckReplace Existing TruckYearCash OutflowsCash InflowsCash OutflowsCash Inflows0 1 2 3 4 2) The company's objective is to minimize costs. Complete the following table to determine whether the existing truck should be replaced. Ignore income taxes. What is your recommendation? Keep Existing Truck Replace Existing TruckYear14% PV FactorNet Cash OutflowsPresent Value of Net Cash Outflows Net Cash OutflowsPresent Value of Net Cash Outflows0 1 2 3 4
What will be an ideal response?
1) Cash flows for each alternative:
| Keep Existing Truck | Replace Existing Truck | ||||||||||||||
| Year | Cash Outflows | Cash Inflows | Cash Outflows | Cash Inflows | |||||||||||
| 0 | $ | 0 | $ | 46,000 | $ | 22,000 | |||||||||
| 1 | $ | 20,000 | $ | 14,000 | |||||||||||
| 2 | $ | 20,000 | $ | 14,000 | |||||||||||
| 3 | $ | 20,000 | $ | 14,000 | |||||||||||
| 4 | $ | 20,000 | $ | 5,000 | $ | 14,000 | $ | 10,000 | |||||||
2) Net present value:
The company should keep its existing truck. The net present value of the cash outflows associated with the existing truck is $6,519 (= $64,793 ? $58,274) less than net present value of the cash outflows associated with the new truck.
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